What does a penalty in the context of a contract imply?

In the context of a contract, a penalty typically refers to a sum that is not related to the actual value of the promised performance. This means that the amount specified as a penalty does not serve as a genuine estimate of damages that could arise from a breach of contract; instead, it is often seen as a way to punish the breaching party rather than to compensate the non-breaching party for losses incurred.

Penalties in contracts are generally unenforceable in many jurisdictions because they do not reflect the principle of compensation for actual harm suffered. Courts usually prefer remedies that aim to restore the injured party to the position they would be in had the contract been performed as agreed.

In contrast to this, a liquidated damages clause is intended to provide a predetermined amount of damages that correlates with the harm caused by a breach and is typically enforceable provided it represents a reasonable forecast of potential damages. An estimate of the promised performance value would reflect a more equitable approach to damages, aligning with the actual performance expected from the contract. Similarly, compensation for both incidental and substantial damages focuses on reimbursing the non-breaching party for losses directly connected to the breach rather than imposing punitive measures.

Thus, a penalty's lack of alignment with the actual damages